How the U.S. should counter China’s economic power play

In the last two weeks, China scored a rare but impressive diplomatic victory against the United States. In spite of Washington’s fierce opposition, most of its major allies – the United Kingdom, Germany, France, South Korea, and Australia – recently announced that they would join the Asia Infrastructure Investment Bank (AIIB), which was founded in 2014 under the auspices of Beijing.

To the Obama administration, this geopolitical setback obviously must sting. The AIIB, with up to $100 billion in registered capital, represents China’s effort to counter the financial clout of the World Bank and the Asian Development Bank, the two U.S.-led existing development banks. Although the allocation of voting shares among the AIIB member states has to be worked out, China is widely expected to exercise decisive influence. (To reassure the Europeans, Beijing has promised to forego its veto power).

Concerned that its allies, tempted by the commercial opportunities offered by the new bank, would get on China’s bandwagon and lend the AIIB much-needed credibility, the U.S. firmly urged them to stay away. Judging by their unseemly stampede for membership in the AIIB, it appears that Washington woefully underestimated the potency of China’s new money diplomacy.

Of course, the long-term prospects of the AIIB are uncertain. Infrastructural projects in developing countries are notoriously prone to corruption, cost overruns, and substandard construction quality. And in the end, the AIIB could well become another gigantic money pit.

But for now, it looks like the centerpiece of China’s new grand strategy – divide and weaken your rivals by appealing to their greed – has been vindicated.

Unlike Vladimir Putin’s Russia, which has attempted to use intimidation and force to expand its influence, China under President Xi Jinping has recently embraced what you might cynically call “greed-centered” diplomacy. As uber-capitalists, modern-day Chinese Communists shrewdly appreciate an elemental truth about human nature that Putin has utterly failed to grasp: fear unifies your opponents, but greed divides them.

The success of China’s greed-driven diplomacy stands in sharp contrast to the failure of Russia’s fear-based strategy. Putin’s war against Ukraine has unified Western countries, which have imposed punishing sanctions against Russia. Meanwhile, China’s greed-centered diplomacy has turned the U.S. against its long-time allies, sending the latter scurrying to Beijing to seek potentially lucrative deals.

If anything, Washington’s failure to stop the China-backed AIIB from getting off to a triumphant start is only the beginning of a new and long contest of geopolitical vision, national will, and financial resources. The AIIB is only part of Beijing’s project to establish a parallel global financial order that can compete for friends and influence with the post-WWII global financial system that the U.S. continues to dominate. Besides the AIIB, China has led the efforts to establish the New Development Bank (NDB), also known as the BRICS bank, which will compete with the World Bank. China has also committed $40 billion to the New Silk Road Fund, its financial vehicle that will invest in infrastructure in Asia as well.

One can hardly blame Chinese leaders for their conviction that money is more potent than bullets in delivering the geopolitical gains they cannot hope to gain through military competition with the U.S. They understand that the essence of capitalism is competitive greed. The dynamics of competitive greed, in practice, means that nations that miss a potentially profitable opportunity, such as the one created by the AIIB and other China-led efforts, will lose out to their competitors. All China needs to do is to exploit this dynamic to its advantage.

While China’s greed-centered realpolitik is clever, Washington can nevertheless muster countermeasures if it can get its act together.

China’s money diplomacy is taking place at a time when the U.S. is voluntarily ceding its traditional leadership role in global trade and finance. The two costly wars in Iraq and Afghanistan have drained American resources and limited Washington’s capacity to maintain its once-unchallenged global economic dominance. Partisan gridlock has further undermined American economic influence abroad. For example, the existence of the U.S. Ex-Im Bank, which provides export financing for American firms to gain global market share, is in peril because of Republican opposition. Democratic opposition to President Barack Obama’s proposed Transpacific Partnership (TPP), a new trade agreement designed to solidify U.S. influence in Asia, calls into doubt America’s commitment to free trade and global leadership.

So, as the Obama Administration licks its diplomatic wounds, it should rethink its approach to China’s sophisticated strategy. In plain language, greed is best countered with greed. In policy terms, President Obama and the Republican-controlled Congress should work together to pass free-trade agreements with Asia and Europe and increase American financial commitments to the international financial organizations it founded so that the U.S.-centered capitalist order is more attractive than the one China is trying to build.

Minxin Pei is the Tom and Margot Pritzker ’72 Professor of Government at Claremont McKenna College and a non-resident senior fellow of the German Marshall Fund of the United States

China’s economy: Caught in a vicious, stubborn cycle

Beijing in early March is supposed to be a cheery place. March is when the country’s rubber-stamp parliament, the National People’s Congress (NPC), holds its annual session. But this year’s festivities were dampened by a slew of gloomy economic data.

Chinese industrial production grew only 6.8% in January and February, the slowest since 2008. Real estate sales plunged 15.8% in value. Fixed-asset investment, the principal driver of Chinese growth, recorded anemic growth at 1.05% and 1.03% in January and February, respectively (compared with 1.49% and 1.42% in the same period last year).

Acknowledging this unpleasant reality, Chinese premier Li Keqiang told the attendees of the NPC that China’s GDP growth will be “around 7%” this year.

But achieving growth of 7% may be a tall order. China is currently caught in a vicious cycle of excessive debt, overcapacity, and a lack of new sources of growth. This cycle was partly caused by the explosion of credit in the wake of the 2008 global financial crisis. In a panicked move to revive growth, Beijing opened the spigot of bank loans and, as a result, companies and local governments went on a borrowing binge that nearly doubled China’s total debt within five years. In 2008, China’s debt-to-GDP ratio was around 150%. Today, according to the most recent estimates by McKinsey, the figure is 282%, the highest among all emerging-market economies.

Besides inflating the largest real estate bubble in world history, this massive infusion of debt also financed many white elephant projects, such as useless infrastructure and excess steel, automobile, and cement factories.

Today, China is paying a heavy price for its debt binge. Many reckless borrowers, in particular real estate developers, local governments, and state-owned enterprises, cannot repay their loans because they have wasted their original investments on unprofitable projects. In the meantime, China’s traditional, investment-driven growth model is plunging the country into a downward spiral of debt and overcapacity. Weak domestic consumption simply is not generating the necessary demand to absorb added manufacturing capacity created by ever-rising investments.

To its credit, Beijing has long recognized the investment-consumption imbalance in its economy. Unfortunately, so far it has taken no effective steps to correct this imbalance. As long as low domestic consumption (currently in the range of 40-50% of GDP, based on varying estimates) continues to constrain demand, Chinese growth is unlikely to pick up speed anytime soon.

Optimists believe that the Chinese government can stimulate growth by cutting interest rates and making loans more widely available. The People’s Bank of China, the central bank, has already cut interest rates twice in the last four months and reduced banks’ reserve ratio (requiring banks to hold less cash in reserves). It is expected to trim rates even further this year.

Such a move is unlikely to have a real impact because the main problem with China’s economy is a lack of demand, not a lack of liquidity. Any increase in liquidity will simply go to over-leveraged borrowers so they can service their loans, not to finance new, productive projects. Sinking more money into the ground will not address China’s underlying economic maladies.

Persistent subpar growth will present a serious challenge to the Chinese leadership, particularly President Xi Jinping.

In the short-term, the risks Xi faces originate mostly inside the regime itself. The likelihood of social unrest caused by deteriorating growth is small because, so far, poor growth has not yet resulted in rising unemployment. The pains are concentrated mostly in two sectors: heavy industry and real estate. And the Chinese Communist Party is highly capable of repressing social unrest.

But near-term economic deterioration will certainly exacerbate tensions inside the party. Because the spoils from growth are dwindling, competition for these spoils will grow more fierce among government officials and provinces. Various bureaucracies and local governments will likely demand assistance from Beijing to increase investment allocations and cut their debt. Making things even worse is Xi’s two-year-long anti-corruption campaign, which has both terrorized and alienated the vast Chinese bureaucracy.

Looking at China’s political calendar, Xi must be concerned about the next Communist Party Congress, which is scheduled for late 2017. His leadership record will be under review. If the Chinese economy maintains its downward spiral at its current rate (roughly half a percentage point per year), the growth rate for 2017 would be around 6%. That’s certainly not a report card that any top Chinese leader would want to present to a resentful constituency gathered to reaffirm his leadership.

Minxin Pei is the Tom and Margot Pritzker ’72 Professor of Government and a non-resident senior fellow of the German Marshall Fund of the United States

What the U.S. and China understand, that Putin fails to see

A surprisingly productive summit in Beijing last week has changed, at least for now, the dynamics in U.S.-China relations.

There is little doubt that the four key agreements reached between Presidents Barack Obama and Xi Jinping—on climate change, elimination of tariffs on IT products, reciprocal visa liberalization, and notice on major military deployments—will help stabilize and advance a relationship that has been adrift for the last year-and-a-half.

The most remarkable fact about the Beijing summit is that it occurred at all. Since Xi came to power two years, he has pursued a hardline domestic agenda and an assertive foreign policy. The deterioration of human rights conditions in China and rising tensions with the nation’s neighbors has put China and the U.S. on a collision course. In fact, shortly before the summit, most China watchers were concerned that U.S.-China relations were drifting toward conflict.

But the outcome of the summit shows that such a conflict is avoidable. Given their irreconcilable differences over democracy, human rights, and visions of global order, the U.S. and China will always be rivals. However, unlike the former Soviet Union, China also shares important interests with the U.S., such as trade, investment, and international peace. The challenge in managing U.S.-China relations is in getting the balance right.

In Beijing last week, Presidents Obama and Xi showed they could walk and chew at the same time. By putting aside their differences over the most contentious bilateral issues, the two leaders focused on the tasks that, if accomplished, could further expand their shared interests.

If we parse the agreements on IT tariffs, visa liberalization, and climate change, China apparently has made more concessions than the U.S. Since the U.S. has no tariffs on IT products, the agreement will result in a loss of import duties for China, estimated at several billion dollars a year. The relaxation of visa controls will similarly benefit American business more because of the ease of travel and the resulting attractiveness of the U.S. as a destination for private Chinese investment.

On climate change, Beijing’s agreement to cap its greenhouse gas emissions by 2030 marks its first formal commitment to limiting emissions and is significant on two fronts. First, Beijing’s pledge will dramatically alter the political dynamics in global climate change talks. Up to this point, China has sided with developing nations and insisted that rich countries should bear the primary responsibility for emission reductions. With the U.S.-China climate agreement, China has essentially abandoned its long-held position. As a result, other developing countries, especially India and Brazil, will likely have to modify their positions, increasing the chances of success at the next United Nations Climate Change Conference, scheduled for December 2015 in Paris.

Second, Chinese commitment to an emissions cap will almost certainly accelerate the country’s energy transition. Although China pledges to increase the share of primary energy production from renewables to 20% by 2030—a realistic task—accomplishing this goal will not be easy since China’s energy demand will be much bigger by then and most of the renewables will have to come from nuclear, wind, and solar. Based on the remarks of a senior Chinese official in charge of climate change policy, a key benefit of committing to a cap on emissions is to force painful restructuring of the Chinese coal-dependent energy industry.

For the American business community, the good news from the Beijing summit is not solely limited to the potential opportunities in China’s energy sector. By opting for cooperation, not confrontation, Xi now must moderate some of Beijing’s unfriendly policies toward Western businesses (such as the aggressive enforcement of anti-monopoly laws). For Xi, repairing China’s commercial ties with the U.S. is also politically necessary. Like his predecessors, Xi would like to be welcomed to the White House for a formal state visit (preferably before the end of his first term in 2017). The successful Beijing summit makes it a near certainty that Obama will be hosting Xi in Washington next year.

If there is one loser in all of this, it is Russian President Vladimir Putin (who was also in town for the Asia-Pacific Economic Cooperation summit). Isolated and pressured by sanctions, Putin has been eager to seek Xi’s support to counter the West. During Putin’s visit to Beijing, China and Russia signed a preliminary agreement on a 30-year natural gas deal which will increase Russian exports of natural gas to China by 30 billion cubic meters a year starting in 2020.

If Putin was hoping that, by building closer energy ties to China, he could count on Xi to stand with him in confronting the West, he must have been sorely disappointed. He has little appreciation of the complexity and interdependence of U.S.-China relations. Putin tends to see things in black and white, but Xi and Obama know how to operate within shades of gray—and they have both come out ahead in Beijing.

Minxin Pei is the Tom and Margot Pritzker Professor ’72 Professor of Government and a non-resident senior fellow of the German Marshall Fund of the United States

Why China’s crackdown on U.S. companies helps consumers

During the past year, Chinese anti-monopoly watchdogs raided four Microsoft offices, investigated chip maker Qualcomm, and vowed to punish Audi and several BMW dealers for essentially charging unfair prices. This week, food giant H.J. Heinz Co. found itself in a storm as Chinese regulators said they found “severely high levels of lead” in the company’s infant cereals.

With yet another high-profile investigation of a foreign brand in China, many argue that the government is singling out foreign firms to support domestic players. The European Union Chamber of Commerce in China has written a white paper criticizing the government’s efforts, suggesting the moves are unfair and protectionist. Foreign direct investment into China dropped 16.9% in July from a year ago, giving ammunition to critics of the government’s investigations.

But are critics of China’s anti-trust investigations right? Or do they indicate attempts by the government to catch up to international standards and even the playing field to eventually create more competition and spur more consumption through lower prices?

First, it is a mistake to lump the anti-monopoly investigations and the consumer safety watchdogs together. The safety regulators have targeted McDonald’s MCD, KFC, and now Heinz HNZ for selling tainted, mislabeled and toxic products to Chinese consumers. Executives have been fined and jailed. These companies have undoubtedly made mistakes that have endangered the health of Chinese consumers. McDonald’s, for instance, sold hamburgers made with expired meat.

The Chinese government is moving to safeguard the food supply chain in response to citizens’ demands. Food and product safety and pollution are the two biggest concerns in China – ahead of paying for medical care and education for family members, according to 5000 interviews my firm, The China Market Research Group, conducted in 2013 across15 cities. In response, the government for instance has been pushing for consolidation within the dairy sector – just as it had in the steel industry – to ensure better quality control and curb environmental degradation.

Second, many companies, such as Qualcomm QCOM and Microsoft MSFT, have come under fire in other jurisdictions like Europe for monopolistic practices in the past. Regulators investigated them and fined them over the course of several decades, while in China these companies have gotten a relatively free pass. Until recently, the Chinese government was overwhelmed by other priorities like poverty reduction and did not devote significant resources into things like anti-monopoly investigations.

Some media reports have painted the wave of investigations as a sudden anti-foreign crackdown, suggesting that it is a move by President Xi Jinping to consolidate power. However, companies have been aware that investigations like these would be coming for some time now. China’s National Development and Reform Commission (NDRC), the body charged with enforcing a portion of the anti-monopoly law, announced the start of many of these investigations in 2011. Xi did not take office until 2012 – a year later.

The series of investigations has given the appearance of a targeted crackdown, though in many ways the reason for this is simply that regulators are only now catching up with the task of regulating the market and reaching standards of market behavior held by other advanced economies. Domestic Chinese firms have also been targeted – many of the BMW dealers targeted for instance are locally owned by Chinese entrepreneurs, not BMW itself. However, these cases have not been in Western news as much.

It is true that regulators need to be more transparent in their investigations and rulings; they should allow lawyers representing the firms under investigation into meetings when decisions and judgments are made. The opaque way many investigations have been carried out has given the appearance of the government making decisions in back rooms to strong-arm brands into lowering their prices.

Finally, although the investigations are hurting profit margins and making executives nervous for now, in the long-term, this will help overall profitability for Chinese and Western brands alike.

Over the past decade, Chinese consumers have been so worried about poor food and product safety standards that they tend to buy the most expensive items they could afford. For key items, such as infant milk formula, consumers shun more affordable brands because they equate lower prices with lower safety. As a result, a few ultra-premium players with high prices have dominated the market, while other brands that aren’t naturally premium-positioned have had little choice but to use high pricing to attract consumer interest.

Promoting better accountability on safety will allow consumers to be more confident in product quality standards and make decisions based on other factors than simply price. In turn, that will give brands the opportunity to carve out new market niches rather than race each other to the top.

Shaun Rein is the founder and managing director of China Market Research Group, a strategic market intelligence firm focused on China. He is author of the forthcoming book, The End of Copycat China: the Rise of Creativity, Innovation, and Individualism in Asia, which is expected to release in October.

China vs. Western companies: Best defense is a strong offense

For more than three decades, Chinese leaders have told foreign CEOs who make the trip to Beijing that they are “friends of China.” In many ways, it is true. It is hard to think of a group that has done so much to bring China into the global economy.

But lately, CEOs of some of the largest Western multinationals are finding that they are not exactly being treated like friends. New Chinese leaders have adopted a far less cordial policy toward foreign businesses operating in China.

The trend actually began a year ago, with Chinese regulators launching “anti-monopoly” investigations against Western baby formula-makers, accusing them of charging excessively high prices. Even though the charges were spurious (the Chinese market for baby formula had over 10 brands), Beijing’s intimidation and harassment forced companies like Mead Johnson and Abbott Laboratories to cut prices to placate the Chinese government.

In recent days, Beijing has expanded and intensified its anti-monopoly enforcement, targeting giant Western companies like Daimler, BMW, Volkswagen, Chrysler, Qualcomm QCOM, and Microsoft MSFT. Many of these companies could face huge fines if they are found to have violated Chinese law.

Although Beijing’s crackdown may have surprised Western business executives, it is actually a logical complement to the new Chinese leadership’s assertive foreign policy. Since his appointment as the new Communist Party chief in November 2012, Xi Jinping has displayed a much less accommodating stance toward the West. You can see evidence such a shift in China’s willingness to escalate maritime territorial disputes with Japan, Vietnam, and the Philippines, and its open embrace of Vladimir Putin of Russia.

In business, the ethos in China is also changing. Economic nationalism is in full swing. Although no country has benefited from globalization as much as China, Beijing in its heart has little trust in an open trading system. Chinese leaders, including the most senior officials, have often publicly expressed concerns that foreign economic influence and technological dominance is undermining Chinese security. Some of these fears have been translated into policy. The Chinese government has kept Apple’s products off its official procurement list (ostensibly because Apple did not submit its applications on time). Cisco’s sales in China have plunged due to security concerns. The Chinese business media also reports a plan to replace IOE (IBM IBM, Oracle ORCL, and EMC EMC, the three companies that dominate IT services for Chinese financial firms) with indigenous equipment and service providers.

In this context, it would be a mistake to view China’s latest anti-monopoly enforcement as isolated acts. Western firms must have a coherent strategy to defend their business rights and interests in China.

Whenever Chinese authorities harass their companies, Western CEOs’ first instinct is to roll over and play dead. This is a bad idea because, unless their firms have truly violated Chinese law and engaged in internationally unacceptable business practices, such a response is guaranteed to invite future aggravation. Western companies should fight back by following China’s legal procedure, demanding transparency, and using the influence of their trade groups (such as the American Chamber of Commerce) to get the facts out.

To be sure, China’s legal and regulatory systems are totally subservient to the Communist Party and will not likely rule against the government. So, the most effective defense is a vigorous offense: if Beijing’s anti-trust enforcement actions have no merit, Western firms should lobby their governments to threaten tit-for-tat retaliation.

Thanks to globalization, China now also has immense economic interests in the West—Chinese companies operate in Western countries and are eager to expand. It must be made clear to Beijing that unfair actions against Western companies will result in unpleasant regulatory enforcement measures targeting Chinese firms in the West.

A strategy of strict reciprocity will likely deliver better results than quiet capitulation or private groveling. For all its economic gains in the last decade, China still lags significantly behind the West in technology, brand building, and innovation. While it is true that large Western firms count on China for future growth, China also relies on Western multinationals for upgrading its economy.

It is unclear if Western firms will be willing to band together to protect their interests. Based on previous experience, European firms are more vulnerable than their U.S. counterparts because European governments lack the heft or the will to confront Beijing. Of course, the Chinese government has exploited this vulnerability fully and has skillfully used the divide-and-conquer tactic, first to separate American firms from European ones and then to show favoritism toward firms from one European country (Germany) over those from another (France).

But this time, let’s hope that Western firms will have the guts to tell Beijing that they want to be treated like real “friends of China.”

Minxin Pei is the Tom and Margot Pritzker ’72 Professor of Government at Claremont McKenna College and a non-resident senior fellow of the German Marshall Fund of the United States

In China-Russia gas deal, why China wins more

To the casual observer, it’s easy to doubt that China and Russia would have ever struck a natural gas supply and purchase deal during Russian President Vladimir Putin’s meeting with Chinese President Xi Jinping in Shanghai last month. After all, countless summits between Chinese and Russian leaders have come and gone with no final agreement signed for the long-discussed plans to ship more Russian gas to China. However, Putin and Xi finally ended an energy courtship, agreeing to a $400 billion deal for the delivery of 38 billion cubic meters of natural gas to China starting in 2018.

Long before the Chinese and Russian leaders on May 21 toasted their supply contract, the two countries had viewed each other as attractive natural gas partners. Russia regarded tapping into the Chinese market as essential to its plans to diversify its exports away from Europe, where natural gas demand is projected to grow at a substantially slower pace than in China. Meanwhile, the surge in China’s natural gas demand in recent years made the Chinese eye their northern neighbor, the world’s largest natural gas exporter, as an important source of supply to fill the gap between China’s domestic natural gas production and consumption.

Developments in the months leading up to the Shanghai summit may have provided Russia and China with added incentives to get serious about a natural gas marriage. For Russia, the new imperative is the country’s increased isolation from the United States and Europe in the wake of Russia’s annexation of Crimea and the resulting Western sanctions.

Europe’s renewed interest in finding alternatives to natural gas supplies from Russia, and the calls by U.S. policymakers and pundits for Washington to expedite the process for granting LNG export licenses and lift the virtual ban on crude oil exports to help wean Europe off Russian energy, undoubtedly made signing a gas pact with China even more appealing to Moscow.

For China, the country’s poor air quality and it’s “war on pollution” declared by Premier Li Keqiang in March likely increased the desirability of Russian natural gas. Indeed, the Chinese government’s announcement in April that the country aims to more than double the country’s natural gas consumption from 170 bcm in 2013 to 400-420 bcm in 2020 means China now needs Russian gas more than ever.

The major obstacle that Russia and China encountered on past attempts to make it to the altar was price. Russia did not want to sell gas to China at a price lower than it commanded in Europe, its largest customer. Meanwhile, China did not want to buy gas at a higher price than it paid Turkmenistan, its largest supplier of natural gas.

Although the Russians and the Chinese have come to a meeting of the minds on price, they are treating it as a commercial secret. Consequently, there has been much speculation by outside analysts about the price implied by the $400 billion contract and what it says about which country got the better deal. A back-of-the-envelope calculation yields an implied price of $350 per thousand cubic meters, which is close to what the Chinese are understood to have paid for gas from Turkmenistan last year. This estimate fits with the consensus among many outside observers in the lead up to the summit that Chinese had the upper hand due to Russia’s strained relations with the U.S. and Europe and the number of natural gas producers eager to supply the Chinese market.

That said, we do not know the pricing formula, the base number to be plugged into that formula or how a variety of other issues on the negotiating table – such as the apparent lack of upstream access in Russia for the Chinese, a rumored prepayment from the Chinese to the Russians, a Russian proposal to exempt gas sent to China from a mineral extraction tax, a Chinese proposal to exempt Russian supplies from an LNG import tax, and expectations about the pace of natural gas price reform in China – influenced both countries decisions about price.

It is also important to note that this is not a marriage among equals. The natural gas supply agreement is the third time in the past decade that the Russians have brokered a multi-billion dollar energy deal with the Chinese in a time of need. In 2005, the China Development Bank and the Export-Import Bank of China were lenders of last resort to Rosneft, providing the Russian national oil company with a $6 billion oil-backed loan to help fund the purchase of the main production asset of a private Russian oil company, Yukos.

Four years later, the China Development Bank extended oil-backed loans worth $25 billion to Rosneft and Transneft, the state-owned pipeline operator, when oil prices collapsed and credit crunch during the global financial crisis left both Russian companies in a world of hurt. These deals have not only deepened bilateral energy relations, but also underscored a shift in power in the relationship away from Russia and toward China.

Regardless of which country may have conceded more, both countries can present themselves as winners to domestic and international audiences. The gas deal signifies that the China-Russia energy relationship is starting to live up to its full potential. Russia, which was China’s fourth largest crude oil supplier in 2013, is poised to become a major source of natural gas imports for its southern neighbor. This arrangement should provide Russia with greater security of demand and China with greater security of supply in the long-term. In the short-term, the main benefits of the gas agreement are political. Russia can claim a powerful friend in China, and China can point to another indicator of its growing economic and political clout on the world stage.

Erica Downs is a fellow in the John L. Thornton China Center at Brookings Institution. She focuses on the international expansion of Chinese companies and China’s energy and foreign policies as well as government-business relations in China, and was previously was an energy analyst at the CIA.

Putin’s China pivot: All tactics, no trust

FORTUNE — For those who remember the days when Chinese leaders were supplicants to Moscow, seeking economic aid and diplomatic favors, Russian President Vladimir Putin’s state visit to Beijing this week was astonishing, even surreal.

On the surface, Putin remains as confident as ever. But everyone watching the swaggering Russian president knows that he had come to Beijing with the proverbial cup in hand. Isolated internationally after his land grab in Crimea, Putin is desperate for support abroad, particularly from China, now one of the world’s most powerful countries.

While the role reversal would have delighted the late Mao Zedong and infuriated the late Josef Stalin, the world has yet to digest what Putin’s trip to Beijing has actually accomplished and whether a new Sino-Russian strategic alliance is a geopolitical possibility.

At the moment, the logic for an alliance seems compelling, at least on the surface. Both China and Russia need each other to counter the West. Economically, Russia hopes to turn China into a huge market for its energy products, reducing its reliance on Europe for energy exports. Geopolitically, Moscow seeks closer coordination with Beijing so that they can jointly frustrate the West’s efforts to promote democracy and economic liberalism around the world.

As for China, having Russia’s abundant natural gas and oil would increase its energy security. In particular, China urgently needs to reduce its consumption of coal to alleviate its air pollution woes. Its only short-term solution is increasing the use of natural gas. On the geopolitical front, China faces renewed American pressure in response to its growing power in Asia. China’s ongoing maritime territorial disputes with Japan, the Philippines, and Vietnam have gained America’s attention. So if Putin can create trouble in Eastern Europe, China would benefit. Likewise, if China ratchets up tensions in East Asia, Putin would gain.

But even compelling geopolitical logic does not necessarily lead to a real strategic alliance. The fragility of the budding Sino-Russian partnership was on full display during Putin’s visit, the centerpiece of which was supposed to be the signing of a long-term agreement for China to purchase Russian natural gas.

At first, negotiations were deadlocked, with neither side willing to budge on prices. The Russians were insisting on setting a high price while the Chinese, sensing Russian weakness, were trying to bargain the rate down significantly. Disaster was averted at the last minute when both sides reached an opaque agreement that would enable Russia to export $400 billion worth of gas to China over 30 years, starting in 2018.

Although the price was not disclosed, Russian media reported that it will be around $350 per thousand cubic meters, roughly the average for Russian gas exports to Europe but lower than the price for gas exported to Germany and other rich Western European countries (which have to pay over $400 per thousand cubic meters).

If anything, the Sino-Russian gas deal epitomizes the nature of the ties between Moscow and Beijing. Their relationship is purely utilitarian and lacks enduring foundations of mutual interest and shared values.

Nations become strategic allies not simply because they share the same potential opponents. They need to have deep trust in each other. At a minimum, trust is easier to build when potential allies have no fear of each other. And such trust becomes unshakeable if they share the same values.

Unfortunately, none of these conditions applies to the Sino-Russian relationship. Russia fears China, which borders on Russia’s sparsely populated far eastern region, part of which was, in the eyes of the Chinese, stolen from China in the late 19th century. Many Russians worry that China will take over that land, either through migration or more sinister means. Unlike the West, which has facilitated China’s rise and has come to recognize it as a reality, the Russian elite has trouble accepting China, impoverished and impotent only a generation ago, as a great power.

Likewise, Chinese leaders are acutely aware of Russia’s quiet strategic balancing aimed at countering Chinese power. For instance, Russia has been the main supplier of arms to India, China’s long-time rival. Russian military hardware exported to India is superior to what it has sold to China. Russia has also provided Vietnam, which is now embroiled in a dangerous confrontation with China in the South China Sea, with advanced submarines and jet fighters that could give the Chinese military a bloody nose if a fight breaks out.

In terms of political values, Putin and the Chinese Communist Party are united in their hostility toward Western democracy. But hatred, unlike love, does not form lasting bonds. In the contemporary world, democracies forge enduring ties because their values are founded on the love of freedom. Dictatorships, by contrast, have no such positive values as the basis of trust — otherwise, Hitler would not have invaded Stalin’s Soviet Union.

So while the West needs to remain vigilant toward both Russia and China, they should not lose sleep over a new Moscow-Beijing axis. Russia and China are tactical partners, pure and simple.

Minxin Pei is the Tom and Margot Pritzker ’72 Professor of Government at Claremont McKenna College and a non-resident senior fellow of the German Marshall Fund of the United States